Slow industries getting slower

When I was working in venture, my job was to find interesting companies and then try to get a partner at my firm excited about visiting the company and potentially investing. Each monday, we’d have a meeting at 5 pm where myself and my 5 peers would each be responsible for presenting 2-4 companies worth talking about. It was a great way to hone my investment prowess, and a good way to figure out what made a company interesting or not.

One theme was always how fast a company can move. When you invest in startups, you need to have the opportunity to compound your money at 100% a year (and the expected compounding, or IRR, should be around 25% factoring in middling outcomes, and zeros), otherwise your losers will pull down your portfolio and you’ll never have big wins that return your fund.

One key to investing in companies that can grow this fast is to have a fast sales cycle. Basically, you can initiate a conversation, demo a product, and close a deal in a reasonable amount of time. For a freemium SaaS company, a reasonable amount of time may be a 14 day trial. For an enterprise SaaS company selling $50k/year software, this may be more like a few months.

During our Monday meetings, there was always constant push back for a couple of industries because the sales cycle was simply too long to build a company that could compound money at 100%/year (even if things went well!). In healthcare, it’s almost impossible to sell anything to insurance companies (it can take 18 months even if the ROI is extremely positive), same with hospitals. The government is unsurprisingly similar, along with the education system. Telecom companies…forget about it. Non-profits are more of the same.

So, that meant that most companies selling to these industries weren’t even on the table for consideration when we pitched them to partners. These companies were most likely at a similar disadvantage in other venture firms’ deal funnels. This is probably even more exacerbated at the seed level. We saw companies who had at least a few million in recurring revenues and had somewhat figured out sales channels that worked (and in fact some of these companies did have an expected IRR in the 20s, and made it into the portfolio, but sometimes this was due more to the decreased risk of a later stage company rather than the ability for an early stage company to move fast)…For seed stage, I can’t even imagine trying to sell the dream of selling a product to these sorts of organizations before there were any hard numbers.

This dynamic is being combated in part by employee software – maybe you can build something so good that teachers will adopt it, and you can then later sell it to the larger school district after a critical mass of users already exists. Freemium models make it easier for organizations to try these offerings as well.

But, the sad thing is that the reputation of these industries means that many high quality entrepreneurs are not trying to start companies that service them. It’s frustrating to navigate bureaucracy. And, it decreases your odds of success due to the increased operational and fundraising risk. No doubt, the lack of new companies in an ecosystem leads to these industries falling even further behind.

I’ve now seen this play out with friends starting companies and weighing different markets, in addition to investors. If you want to succeed, there is an unwritten list of industries to stay away from.

It’s scary that some of the most important aspects of our society are disadvantaged because of slow procurement processes. In many cases, I’m sure this could change with the right incentives and training. But, it seems like most of these players will have to hit rock bottom before anything changes. Or, maybe a few pioneers can turn the tide. I thought it was really cool when I noticed a developers page on the MBTA site. Hopefully others take note.

  • http://www.skookum.com/ Pat Morrell

    This is a reality that also informs biz dev decision-making at tech/innovation consultancies. My team recently opted out of a mobile app RFP from a large NC municipality because the 100+ page RFP + procurement process was bureaucratically onerous.

    Agree that the tide won’t turn until “the right incentives and training,” as you put it, are in place for the actual flesh and blood people who have the buying power. To that end, I dig what organizations like 18F are trying to do on the gov’t front (http://www.washingtonpost.com/business/on-it/meet-18f-the-gsas-bid-to-change-federal-it/2014/04/18/a9b58db8-c4d3-11e3-b195-dd0c1174052c_story.html).

    • http://philstrazzulla.com philstrazzulla

      Hey Pat,

      Thanks for the note. Very interesting that your team opted out of pursuing the RFP…My hope is that this is a problem that goes away as organizations start to realize they need to adapt or get way left behind.